The Insanity of Trying to Predict Interest Rates

I find it hilarious that every time Young posts a net worth update or you stumble across any article that mentions interest rates you immediately get a bevy of “experts” that come out of the woodwork to explain why everyone else is a moron and that it is obvious to them exactly what interest rates will do. The confidence of these individuals astounds me. Sure, the smartest economists in the world readily admit to not being able to predict how interest rates will move, but I’m sure your economics 101 course covered these sort of predictions on the mid-term right?

So You Think You're Smarter Than a Bond Trader?

It is ridiculous on so many levels to tell yourself that you know exactly what interest rates are going to do. Anecdotally, one only has to look back a few years to a time when everyone was advocating locking in mortgage rates because “inevitably” rates were going to rise soon and steeply (this is still the case btw). How did that work out? Even the guys that paid big bucks to do this for a living rarely forecast out further than two years, and even those predictions have been proven to be more guess than prediction. In July 2009 the Wall Street Journal asked fifty interest forecasters what the interest rate on the benchmark 10-year treasury note only one year later. Forty three of the “experts” predicted higher rates, while five more predicted static rates. When there is such unanimity across expert opinion, the prediction MUST have come to fruition right? Wrong! Rates went from 3.5% to 2.95%. Even Bill Gross, the man commonly described as the world’s best bond trader (and subsequently, greatest predictor of interest rates) has been stumped by the current interest rate environment. He predicted interest rates inevitably would rise (as many people feel confident enough to do on this site every week), of course the current 10-year US Treasury rate is hovering around 1.7% so Gross had to eat massive losses. He has even been quoted as saying he has “lost sleep” over the investments he made based on his treasuries prediction. Personally I'll stick to my index ETFs!

Sounding Smart vs Sounding Correct

It’s not really that hard to make a plausible case either way when talking about interest rates. Just use a lot of partial truths and spin in order to sound convincing. For example, I could say something like, “With all of the ‘cheap money’ that governments around the world are pumping into economies interest rates are bound to skyrocket as money supply move lead to record inflation numbers.” However, it’s equally true that, “Recent Canadian inflation numbers were well below the 2% target rate the Bank of Canada sets as their standard. With the USA promising to keep rates low until 2015, it is highly unlikely Mr. Carney will move off of the current 1% mark due to the intense pressure it would put on Southern Ontario’s already toppling manufacturing-dependent economy.” I don’t even really know how true each of those statements are, but I know they sound logical, and that pieces of them definitely have some truth (like the best lies?).

There might be someone out there, or a small group of people that can predict interest rates with some degree of success or accuracy. Most likely they would be aided by a supercomputer and a complex algorithm that would serve as a useful model until it was broken by the next fundamental shift in the economy. In any case, if these people exist, they certainly wouldn’t be sharing that information with anyone else, they would be making boatloads of money off of it as fast as they could while they still had an advantage. Anyone whole believes that basic journalists or random anonymous bloggers/commenters know where interest rates will go with any degree of certainty simply needs to look at the track record of bond traders and predictors across generations to realize that it is all hot air and they might as well go outside and ask their dog. At least you know he doesn’t have a private agenda right?

As far as us regular folks go, there are two types two types of people in this world when it comes to predicting interest rates: those who don’t know where interest rates will be a year from now and those who don’t know that they don’t know where the interest rates will be a year from now. Pretty simple don’t you think?

7 Comments

I was one of those people who locked in my mortgage rate for 5 years almost 5 years ago because interest rates were bound to go up. Not only did they not go up, but the rates of that day look high compared to the rates of today!

Oh well, at least it gave me stronger motivation to pay off my mortgage faster!

Thanks Andrew! I actually often read the comments you guys get over there. Crazy stuff. I know that if I could predict interest rates I sure wouldn’t be wasting valuable time blogging or commenting anywhere.

sleepydadon November 22, 2012 at 2:18 am

Doesn’t everyone have a crystal ball in place that doesn’t work?
From predicting stocks, price of gold/silver, exchange rates, I don’t think anyone knows! But then is it better than flipping a coin?

I, like alot of others, also have thought the interest rates would have risen by now; but obviously it hasn’t. I locked in at 2.99% for 4 years back in April when all the deals came out. Still not bad of a rate, but i’ve left my smaller mortgage at variable and its only at 2.3%

Actually a lot of people have argued pretty convincingly that the majority of mutual fund managers who actually do beat the market consistently over 10 years or so (VERY few and far between) are merely the best coin flippers, and that if you get enough guys flipping coins a few will flip 10 straight heads or tails.

Overall I agree with Teacher’s assessment about the pro’s attempts to determine the direction of interest rates. However, you can’t blame a bunch of people who in the summer of 2009 predicted rates would go higher when they were at historical lows. No one is going to say there going to go lower when the market had hit bottom that March and showed signs of a turnaround. Likewise no one would have ever speculated that Bernanke and company would have stepped in for QE1, QE2, QE whatever, direct purchase of MBS and Operation Twist and further intervened in the market and lowered rates to a point than would have been otherwise possible with normal market operations. It just shows the fact that no one knew exactly how long it would take to unwind all the garbage that was created by the financial crisis. As a technician I do put the bond guys at the head of the class about the direction of interest rates and as a result a proxy for the economy including the risk on/risk off conversation that develops as a result. Whenever I need a clarifying point when I have conflicting data the movement in bonds is a good indicator of which set of signals I should be investing with.

I think the overall point that we agree on is that if bond traders like Bill Gross are the smartest guy in the room, and they are getting it wrong (and in a huge way really), to claim that anyone can accurately do this is crazy.

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